
BY MARILOU C. VROMAN, CPA, CFE
Factory warranty fraud in automotive dealerships can be a tempting source of revenue in a time when margins are being compressed, and profits start to decline from historically high levels. The short-term financial gains realized in perpetrating warranty fraud can ultimately result in significant financial losses, legal consequences, and reputational damage with the manufacturer. In day-to-day processing of warranty claims, some individuals may be tempted to manipulate the system for personal gain. Understanding the types of factory warranty fraud, how it happens, and what dealerships can do to prevent it is essential for protecting the bottom line and the dealership’s integrity.
What is Warranty Fraud?
Warranty fraud occurs when a dealership or individual manipulates the warranty process to claim reimbursement from an original equipment manufacturer (OEM) for work that was not performed or parts that were not installed with the objective of increasing revenue, gross profit or personal compensation.
Warranty fraud can be perpetrated by service managers, service advisors, technicians, or parts managers or combination thereof. High pressure on the service department’s monthly financial performance objectives is often at the heart of warranty fraud, and a byproduct of higher performance metrics is often higher compensation for those involved. Warranty fraud may be perpetrated by multiple individuals through collusion such as an advisor, technician and parts counter person working together, which further increases the risk of going undetected. Employees who are party to fraudulent activities may not be fully aware of the magnitude of risk to the dealership and feel insulated, so the risk-reward evaluation becomes simple. In their opinion there is much to gain, and little to lose. Regardless of the motivation or perpetrator, the consequences can be severe for the dealership including financial chargebacks and compromising the dealer agreement and straining factory relations.
How is warranty fraud perpetrated?
Warranty fraud can occur in many ways, and its pervasiveness is often contingent on the weaknesses in the process, where individuals may justify the behavior and find the opportunity to take the risk without detection. Several ways to facilitate warranty fraud are:
Falsified Labor
An employee may submit warranty claims for work that was not performed or for more hours than were worked on a vehicle. This can involve simply inflating the time needed to perform repairs or submitting claims for work that was not done at all. For example, a technician might claim to have spent diagnostic time which was not done at all.
Fictitious or Aftermarket Parts
Parts warranty fraud involves submitting claims for parts that were not installed in a vehicle. A repair order may represent that a part was defective and replaced, when it was not replaced at all. While this scheme may be difficult to perpetrate when the OEM requests the faulty part to be returned, there are cases where parts may not need to be returned, so there is no physical proof needed for the parts failure, or its replacement and the fraud may go undetected. This scheme can be taken one step further if faulty parts do need to be returned, the parts may be replaced, but cheaper aftermarket are physically installed on the vehicle while factory warranty reimburses the repair at higher priced OEM parts.
Falsified Diagnosis
This occurs when the technician’s diagnosis is knowingly incorrect, such as stating various test results or failure codes to warrant a complicated repair. A technician might intentionally misdiagnose a small issue as a more costly repair to flag extra labor hours and the fraudulent claim pays for the repair.
Unauthorized repairs or duplicate payments
A dealership may submit a warranty claim for a repair that was previously paid for by the customer, essentially being paid twice for the same repair. Customers are required to approve warranty repair orders. Further to this example, repairs may be performed while the customer is unaware of the claim that was submitted under warranty.
How to Detect and Prevent Factory Warranty Fraud
As with most frauds, factory warranty fraud can be difficult to detect and eliminate entirely. However, simply monitoring warranty activities may serve as a deterrent. Just as installing cameras tends to deter theft, watching closely over the warranty process, particularly by those who receive no direct financial benefit from warranty sales, may be enough to prevent fraudulent activities.
Monitoring OEM reports:
Manufacturers monitor warranty claims by dealerships for unusual patterns such as volume of claims, recurring claims, rejection rates, repair times and frequency of defects. Review of these warranty health assessments and benchmark reports can provide indications of inappropriate activities.
Internal Audits:
Internal audits of warranty claims are a proactive measure to help identify fraudulent activities before it comes up in a factory warranty audit. An individual from outside of the service department should conduct periodic reviews of the warranty process as follows:
Review repair orders with high labor hours and run comparative technician time reports which may indicate excess labor hours for certain technicians or operation codes.
Monitor volume of aftermarket parts purchases, particularly for fast moving or high-volume maintenance or recurring claims.
Select warranty claims with expensive parts and cross reference to physical bin checks to identify parts overages which may indicate billed but unused parts.
Physically inspect parts bins for non-OEM parts in bins intended for OEM parts. Check packaging and look for OEM logos.
Run service performance reports showing service advisor and technician pairings by repair order to identify patterns of correlation between one service advisor and one technician to reveal repair orders with higher risk of collusion.
Review service history to identify data inconsistencies such as:
Erroneous vehicle mileage readings
Flagged labor hours inconsistent with actual punch times
Technician story not aligning with parts used or complaint, cause and correction
Incorrect or modified customer contact information such as email address
Sublet rental or loaner days misaligned with repair order date
Verify quality of supporting paperwork such as:
Documented test results
Customer approval signature
Manager approval on in stock units
Parts return sign off by technician
Approval of add-on lines
Copy of sublet rental bill or loaner agreement
No tolerance policy
Create a culture of integrity and awareness of the risks associated with warranty fraud and benefits of compliance. Instill an environment where committing fraud places the perpetrators employment at risk and may result in termination. Document employee acknowledgement of the dealership’s compliance policy as it relates to warranty processing. Ensure all employees have open lines of communication and feel comfortable reporting inappropriate behavior to the dealer principal or the leadership team without fear of repercussions.
Conclusion
Factory warranty fraud is a serious problem that can have significant consequences for retail automotive dealerships. Knowing what is deemed fraudulent, learning to recognize potential red flags can help mitigate the risk before it gets to the manufacturer. Prevention through monitoring, internal audits, and fostering integrity is the best medicine. As a veteran car guy once told me, “It hurts less to punch yourself, than to let someone else do it.”
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